Analysis: Bank MPC at war on interest rates

By Simon Duke for MailOnline
Updated: 06:39 EDT, 4 September 2008

Civil war is just about the last thing that you'd expect to erupt at the Bank of England - a paragon of sobriety in London's febrile financial markets for over three centuries.

Mervyn King: The Governor has been caught in the middle of MPC disagreement

However, unusually forthright comments from policy makers in recent weeks have exposed deepening divisions in Threadneedle Street over how to respond to the growing economic crisis.

On one side there is David Blanchflower, who appears ready to press for an emergency half-point interest rate cut at this month's Monetary Policy Committee meeting, which starts today.

The Bank's resident prophet of doom, Blanchflower has urged fellow MPC members to 'get ahead of the game' and start slashing borrowing costs now to forestall a long and painful recession.

On the other stands Tim Besley, whose controversial call for a rate hike split the Committee into three at the past two meetings.

Between the two sits governor Mervyn King, who will probably vote to hold rates steady at 5% due to soaring inflation.

Just a day after unveiling his £1bn plan to stop the rot in the property market, Gordon Brown must now be praying for an emergency rate cut when the MPC delivers its verdict tomorrow.

But any hopes of an early Christmas present are likely to be dashed, with the Bank widely expected to wait until November at the earliest before cutting rates.

The widening rift at the Bank mirrors the increasing uncertainty hanging over the economy.

Growth came to a shuddering halt in the second quarter for the first time since the recession of the early 1990s.

Tim Besley

Britain's hitherto robust manufacturing sector contracted by a worrying 0.8%, and with the services industry also succumbing to the credit crunch, many economists believe a recession is now unavoidable.

Add in falling house prices and the growing economic crisis in key trading partners Germany and France, and it's little wonder that Blanchflower is calling for immediate action.

Hitherto a lone advocate of lower rates, the Ivy League economics professor appears to be gaining more sympathy from his fellow MPC members.

The normally phlegmatic King recently warned that the economy faces an 'extremely difficult' year. Meanwhile deputy governor Charlie Bean said a series of financial 'grenades' has triggered the gravest economic threat since the 1970s oil crisis.

Indeed, the dire growth figures and the slew of gloom-ridden surveys from all corners of UK plc may persuade some MPC members to defect from King's camp.

George Buckley, an economist at Deutsche Bank, said: 'You'll see a shift in sentiment towards a rate cut.

'The feeling is growing that weaker economic growth will soon begin to take its toll on inflation.'

David Blanchflower

Blanchflower is a professor at Dartmouth Colleague who splits his time between here and America. It appears that the US Federal Reserve, which has cut interest rates by a whopping 3.25 percentage points to just 2% since the credit erupted, has had a strong influence on his thinking.

British homeowners struggling with sky-high mortgage rates shouldn't expect the Bank of England to follow the Fed's suit.

The US authorities have twin goals of maintaining economy growth, while also keeping a lid on inflation.

By contrast, the MPC's sole mission is to get a firm grip on the inflationary levers.

The Bank's narrower mandate means that rate cuts are unlikely until the effects of sky-high oil and food prices washes through the system. Inflation soared to a 16-year high of 4.4% in July - over twice the official target - and is expected to peak at over 5% this Autumn.

The good news is that the recent retreat in oil prices, coupled with the downturn in the broader economy, should help dampen the inflationary fires. However, the recent run on sterling following Chancellor Alistair Darling's dire prognosis for the economy muddies the waters.

A weaker pound means that imported goods, like oil, gas and food, could get more expensive for British consumers. With the inflation bugbear showing few signs of disappearing, it may be a while before harmony reigns again at the Bank.